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Sunday, 23 April 2017

Contractor Whose Business Model Is Price Gouging the Pentagon Has Powerful Wall St. Backers

On March 21, first-term Congressman Ro Khanna sent a letter asking the Pentagon’s inspector general to investigate TransDigm, an aerospace supplier he accused of cornering the market on proprietary parts for military aircraft and then jacking up the prices.The California Democrat charged that TransDigm operates as a “hidden monopolist,” to “enrich a few individual financiers who stand to benefit at the expense of our troops and weapons systems.”The letter rebounded across Washington and Wall Street. TransDigm stock dropped over 10 percent in two days. The business press highlighted the story; The Huffington Post called TransDigm “The Martin Shkreli of defense contracting.”In a nation that once saw a senator become president in part because of his investigation of war profiteering — and where memories of the Pentagon buying $640 toilet seats still linger — the story of a greedy corporation ripping off the military seemed to have legs.But by April 11, TransDigm stock was back up to $236.48, virtually the same level it was at the day before Khanna’s letter. Investors had shrugged off the bad publicity, and the potentially damaging investigation.It appears that the hedge funds, Wall Street banks, and highly paid executives cashing in on the scheme are confident that they can use the power and influence that comes with big money to prevent public outrage or government investigations from ruining their party.And so far, they’re right.TransDigm, based in Cleveland, is more of a private equity-style conglomerate than an aerospace company. The company uses borrowed money to buy companies that make aerospace parts used in both military and civilian aircraft. About 30 percent of its revenue comes from military sales. And according to TransDigm’s 2016 annual report, “about 80% of our sales come from products for which we believe we are the sole-source provider.”Because the parts are required for aircraft, TransDigm can raise prices after acquisition without any expected loss in sales. For example, it bought a company that makes motor rotors from GE in 2013. After renaming the subsidiary Whippany, TransDigm raised the rotor’s price ninefold, from $654 to $5,474. Similarly, a vibration panel from Aerosonic rose from $67 to $271. A cable assembly from Harco jumped from $1,737 to $7.863.While the increases are large, they’re not enough to meaningfully affect the total cost of an aircraft, allowing TransDigm’s profiteering to fly below the radar.The government has rules preventing price gouging from sole-source contractors, by forcing the business to provide information on the cost of production. But TransDigm circumvents this, Khanna and critics allege, through “a network of captive distributors” that create a fake market. Defense procurement officers think they’re choosing between distributors to purchase the part, but the distributors fail to disclose that they all have the same corporate parent: TransDigm. Therefore, government officials don’t know to ask for additional cost information.The parts aren’t even reliable: an advanced drone keeps crashing, and Air Force officials blame a faulty starter-generator built by a subsidiary of TransDigm.Though TransDigm’s profits rose 31 percent last year, the company’s debt has tripled since 2012. That’s because instead of paying down debt, profits get siphoned out by executives and shareholders.CEO W. Nicholas Howley earned $64.2 million in 2013, mostly from dividends on stock options he didn’t even own yet. According to the company’s 2017 proxy statement, Howley received $61.5 million from 2014 to 2016, also mostly from dividend payments and options.Meanwhile, shareholders enjoyed a “special dividend” of $24 per share in October 2016, a one-time payout similar to what private equity investors receive. TransDigm issued similar cash dividends in 2012, 2013, and 2014.This financial engineering pleases investors, many of which are hedge funds and other institutional types like Capital World Investors, which just picked up 10 percent of the company. It’s also good for major banks, which finance TransDigm’s debt. In 2016, just one debt offering by TransDigm was handled by Morgan Stanley, Credit Suisse, Citi, UBS, Barclays, Credit Agricole CIB, Goldman Sachs, HSBC, and Royal Bank of Canada. Banks also take fees when hedge funds trade the stock. The entire thing is mutually reinforcing for large financial interests.https://theintercept.com/2017/04/13/contractor-whose-business-model-is-price-gouging-the-pentagon-has-powerful-wall-st-backers/

It's really important to understand how corrupt systems operate in order to (eventually) stop them. The finance side of the economy is corrupt and bloated and is focused to largely benefit the few while neglecting core business (manufacturing) principles. The lack of a true market system can be detrimental in terms of efficiency and the cost of goods - especially when the lack of a true market is designed to drive prices up (as opposed to oppressing prices - another model of economic control).